Sugar: Sugar: Time for one -...

16th October 2006

By: Pankaj PandeyAssociate: Sanjay Manyal

Sugar: Sugar: Time for one more cuppa

Time for one more cuppa

Table of ContentINVESTMENT RATIONALE 2

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Global SceneIndia SEU impact on world marketGlobal ethanol trends Ethanol: Domestic scenarioCrude prices: Supported at US$60 per barrel

Aggressive capexCapex to drive earningsDiversified revenue streams

Fastest growing companiesKey picks

Renuka SugarBalrampur ChiniBajaj Hindustan

: Fears overdone: Mimicking global trends

ugar Prices: Outlook firm6789

Sugar companies: DNA transformation10

Playing the devil's advocate 11

Compelling Valuations12

Key risks to our view 13

Investment Picks141822

SUGAR

INVESTMENT RATIONALE

We are initiating coverage on the Indian sugar sector with an Outperformer rating given the firm outlook for sugar prices, aggressive capacity ramp-up by sugar companies and compelling valuations.

Firm price outlook: We expect global sugar prices to remain firm over the medium-to-long term, driven by global demand- supply mismatch and exit of European Union, a major player in the market.

Ethanol-the wild card: We expect global ethanol demand to act as a wild card in keeping sugar prices firm in the long-term. Global interest in ethanol as an alternative fuel would result in more cane being diverted to produce ethanol, thus keeping a sustained upward pressure on sugar prices. Even a 1% ethanol blending anticipated globally by 2010 would require more than the entire sugar cane output of Brazil.

Higher revenue visibility from byproducts: The integrated business model followed by Indian sugar companies is expected to yield higher revenue visibility going forward from byproducts including ethanol and power. This is also expected to reduce the cyclical nature of business. Sugar companies are slated to derive about 15-20% of revenues from byproducts post expansion. This would reduce their dependence on sugar.

We initiate coverage on Shree Renuka Sugars, Balrampur Chini Mills and Bajaj Hindustan with an Outperformer rating, our preferred exposure in that order in the industry. The recent correction in sugar companies by 50-60% has thrown up significant value buying opportunities for long-term investors. We believe these companies are geared to capture emerging opportunities with their integrated business models and are compelling buys at these levels.

2SUGAR

3SUGAR

q Demand-supply mismatch to continue: The global demand-supply situation for sugar will continue to be evenly poised despite production of 149.20 million tonnes (MT) in 2005-06. This is 4.63 MT more than the previous year's 144.57 MT. Higher production from Brazil and other countries including India would be offset by lower production in Europe at 16.48 MT in 2006-07 against 21.85 MT a year ago following its exit from the export market.

q Inventory levels declining: Global sugar inventory levels have been declining from 38.38 MT in 2003-04 to 30.97 MT in 2005-06. They are set to fall further to 30.92 MT in 2006-07 as consumption grows at a steady pace, while the cyclical nature of the business caps production intermittently.

q No pause in consumption growth: On the other hand, consumption continues to increase by about 2% per annum and is expected to sustain its growth momentum with rising affluence in emerging nations such as China. China's sugar consumption has been steadily rising and has increased by 50% in the last 10 years to 11.2 MT in 2006-07.

Global Scene: Fears overdone

Source: USDA, ICICIdirect Research

30.9230.97

38.38

34.17

11.8713.19

9.74

10.87

0.00

10.00

20.00

30.00

40.00

50.00

2003-04 2004-05 2005-06E 2006-07P 0

2

4

6

8

10

12

14

Closing Stock (in MT) Sugar Prices (Cents/ pound)

Source: USDA, ICICIdirect Research

Exhibit 1: Global demand supply evenly poised

Exhibit 2: Depleting Inventory to support prices

Demand-supply conditions, falling inventory and rising consumption are likely to put upward pressure on global sugar prices.

142.41

139.58140.68

142.30

144.57143.84

149.20

145.73

134.00

136.00

138.00

140.00

142.00

144.00

146.00

148.00

150.00

2003-04 2004-05 2005-06 2006-07

World Production World Consumption

in M

T

4.133.634.63

11.66

8.412.18

14.41

17.57

18.3

17

0

2

4

6

8

10

12

14

2002-03 2003-04 2004-05 2005-06E 2006-07P024

68101214

161820

Closing Stock (in MT) Sugar Prices (Rs/Kg)

4SUGAR

q Inventory level - Status quo maintained: Domestic sugar production during the crushing season (Oct 06-Sept 07) is set to outstrip demand as India is likely to achieve the highest ever production of 22.5 MT. However, with consumption expected to grow at 5.26% to 20 MT, this is likely to lead to a marginal increase in inventory levels at 4.13 MT, which is equivalent to 2.47 months of consumption against 2.29 months a year ago.

q Export ban - A momentary setback: We believe that the current ban on sugar exports, blamed for keeping prices down, is likely to be lifted by this calendar year end as companies need to re-export 1.324 MT of refined sugar under the export obligation fixed earlier.

q Price dip-Short-lived: We expect domestic sugar prices to stabilize around Rs 17-18 per kg as declining inventory and rising consumption would keep prices buoyant despite jump in production.

India: Mimicking global trends

We expect domestic sugar prices to remain firm over the medium-to long term on positive structural developments globally, although short-term volatility may stay for few more months.

Exhibit 3: Domestic Demand - Supply Scenario

20.14

13.9912.69

19

22.5

18.3417.29

18.5 1920

0

5

10

15

20

25

2002-2003 2003-2004 2004-2005 2005-06E 2006-07P

in M

T

Production Consumption

Source: ISMA, ICICIdirect Research

Exhibit 4: Inventory to keep prices firm

Source: ISMA, ICICIdirect Research

5SUGAR

q Global price decline not supported fundamentally: The decline in global sugar prices appears to be function of liquidity squeeze rather than fundamentals as global inventory levels continue to be at the same level.

q Price dip - A short-lived affair: We expect domestic sugar prices to stabilize around Rs 17-18 per kg on a conservative basis as declining inventory & rising consumption would keep the prices buoyant despite jump in production.

Sugar Price: Outlook firm

Exhibit 5: Prices to recover

Source: ICICIdirect Research

Much of the domestic & global bad news has already been factored in the market. We expect domestic prices to stabilize in the range of Rs 17-18 per kg on a conservative basis. We also do not expect a rally in the sugar prices

either from the current levels in the medium term.

Domesticpriceses lessvolatile

6SUGAR

q Structural changes in EU to impact global sugar market: The exit of one of large sugar exporter, the European Union (EU), is set to have far reaching implications on the world sugar market. EU exports were highly subsidized and are about to change due to the WTO regulations, which would come into effect after May 2006. This would force EU to undertake a one-step reduction in cross-subsidized exports of sugar.

q The EU is a key player in the global sugar market with production of more than 21 MT. It has also been one of the largest exporters, with exports ranging between 4-6 MT per annum. EU exports would be restricted under WTO regulations to 1.27 MT per year from 2006-07 onwards as against earlier 7.2MT. Lower exports will result in an equivalent decline in production from 2006-07 onwards. (See Exhibit 6)

EU impact on world sugar market

Reduced EU exports would have a positive impact on world sugar prices. Additionally, lower EU exportvolumes would provide market access opportunities for countries such as Brazil and India

Exhibit 6: EU exports to dry up

3.64

5.19

4.54

5.4

7

1.27

0

1

2

3

4

5

6

7

8

in M

T

00-01 01-02 02-03 03-04 04-05 05-06 06-07E

5.9

Source: USDA, ICICIdirecct Research

7SUGAR

q The ethanol wild card: Sugar prices have one more trigger in the form of ethanol consumption, which is emerging as a most economical feedstock for alternative fuel sources. World ethanol consumption is slated to reach 54 billion (bn) litres by 2010, accounting for about 1 percent of world oil consumption.

q Brazil meets more than 20% of its transport fuel requirement from ethanol. Brazil, the worlds' largest sugar producer and exporter diverts an equal proportion of sugarcane towards production of ethanol and sugar respectively. With ethanol demand looking only northwards, any tilt in Brazil's ethanol-sugar ratio towards ethanol for export purpose to countries such as US would keep sugar prices firm going forward.

q Brazil, the largest producer of ethanol at 16.05 billion litres in 2005-06, is unlikely to meet the entire additional ethanol demand estimated at 27.2 billion litres by 2012 paving the way for countries such as India to meet the unfulfilled demand. India in turn can become a net exporter of ethanol as well as sugar. We believe the transition towards a blending policy worldwide is not far off, putting pressure on the inventory levels. See Exhibit 7.

Global ethanol trends

Source: Planning Commission, ICICIdirect Research

The additional 27.7 billion litres ethanol demand by 2012 would require about 345 MT tones of sugarcane, which is about 80% of the total sugar cane produced in Brazil in 2006-07.

Country Potential

Demand in bn litres

Remarks

Japan 1.8 Voluntary 3% ethanol blending to be adopted for all of the gasoline consumed in the country

US 13.5 US after passage of the Renewable Fuels Act in 2005, requires for minimum usage of 28.4 billion litres of biofuels for transportation purposes by 2012

China 4.5 China to extend the existing 10% ethanol blending mandatory in some provinces to all.

EU 7.4 A European Union directive has set the goal of meeting 5.75% of transportation fuel needs in all member states with biofuels by 2011

Total 27.2

Exhibit 7: Top 4 regions to drive global demand

Exhibit 8: Ethanol opportunity 2010-12

16.5

27.2

54

0

10

20

30

40

50

60

in bn

litre

s

Brazil 05-06Eproduction

US, China,Japan, EU

World

Source: UNICA, ICICIdirect Research

Exhibit 9: Brazil's ethanol-sugar ratio 05-06E

50%50%

Total Sugarcane outputin 05-06E 428 MT

Source: UNICA, ICICIdirect Research

8SUGAR

We expect ethanol initiatives to gather further momentum in the country not on the cost basis but due to the fact that it has the potential to save substantial foreign exchange, lower environmental pollution and provide better returns to more than 7.5% of the rural population. Indian ethanol programme though in nascent stage is still competitive as the cost of ethanol production is in the range of Rs 14-15 per litre (See Exhibit 10). We expect ethanol production cost to become even more attractive on following factors.(a) Economies of scale: It has taken Brazil more than two decades to

become competitive.(b) Fiscal incentives to be provided to industry: Ethanol can also be

blended with diesel besides petrol upto 5-10% easily and any fiscal incentives towards promotion of the same would further lower production cost.

(c) In addition to ethanol's fuel value, blending of it with petrol prevents formation of carbon monoxide resulting in lower poisonous emissions into the atmosphere and would also qualify for carbon credits under the Kyoto Protocol.

Indian companies to benefit: We expect Indian companies with their integrated business model to benefit from this gradual move to ethanol as auto-fuel. Any diversion by Brazil in either direction towards ethanol-sugar ratio would keep sugar or ethanol prices firm globally thereby culminating into improved financials numbers for integrated Indian sugar companies.

Ethanol: Domestic scenario

Particulars Integrated Model Cost of Molasses ( Rs per ton) 2500Transportation cost (per ton) 0Total 2500 Recovery of ethanol/MT molasses 225Cost of Molasses in Rs per litre 11.11

Total Direct Cost (including chemical, labour, repair etc.) in Rs per litre 0.62

Total Finance cost (including depreciation, indirect overheads etc.) in Rs per litre 2.77 Total cost (in Rs per litre) 14.50

Source: Planning Commission, ICICIdirect Research

Exhibit 10: Ethanol production cost for Integrated players

Exhibit 11: Ethanol supply - not a constraint

187.00

19.10

1.87

0.53Ethanol req. at 5%

blend (bn litres)

Ethanol Possible (bn

litres)

Sugar Produced in

MT

Total Sugarcane

availbility in MT


9SUGAR

Crude prices: Supported at US$60High crude oil prices have stoked interest in alternative fuel sources such as ethanol, which inturn has bolstered prospects for sugar companies and contributed to the rally in sugar prices globally. Increased usage of ethanol as a fuel feedstock has resulted in sugar prices tangentially connected to the price of crude oil.

The recent decline in crude prices from US$78 per barrel to US$58 per barrel has evoked concerns that ethanol would become unviable at current levels. A lot of voices are heard off-late forecasting that crude prices could rise to US$100 per barrel or ease to US$50 by the end of 2008. Some have even forecasted crude at US$25 per barrel. Most of these predictions are based on assumptions ranging from slowing down of global economy to supply disruptions from Iran, booming Chinese demand and other factors including threat from hurricanes in the US, etc.

We don't believe that the recent dip in crude oil prices will pose any threat to ethanol potential usage. Brazil, which is often cited as a role model for cutting dependence on imported crude oil, produces ethanol at a cost equivalent at $25 a barrel of gasoline. Countries like India, Malaysia and Indonesia are ideally placed to harness such renewable fuels, thanks to rich soils, ample sunlight and year-long cropping.

We believe that crude oil prices would hover between US$55-65 per barrel as OPEC is expected to defend prices at US$60 per barrel. Expectations of crude dipping to US$40 per barrel are far-fetched.

Exhibit 12: Crude to get support at US$60 per barrel


10SUGAR

Sugar companies: DNA transformationIndian sugar companies are set to witness major transformation in their revenue sources as the emergence of byproducts such as ethanol and power is likely to put an end to their fluctuating fortunes. The integrated nature of sugar business has now thrown new avenues for revenue generation such as distillery operations, power co-generation and manufacturing of bio-composites along with the traditional sugar business.

Aggressive capexDomestic sugar companies have undertaken a massive capital expenditure of about Rs 10,914 crore. The implementation of 111 projects would increase crushing capacity by 3,79,000 tonnes crushed per day (TCD). The completion of these projects is expected to result in an additional sugar production capacity of about 3.8 MT, which is about 19% of the total estimated consumption of 20 MT in 2006-07E. Indian annual consumption is expected to grow 5% annually despite intermittent hiccups in production due to the seasonal nature of sugarcane.

Capex to drive earningsThe additional capacities, once they come into production, would be fed largely by increased cane acreage, which would thus lead to higher sugar production from sugar year (SY) 2006-07 onwards. Sugar companies are expected to enter into higher growth trajectory as growth in volumes on the back of capacity expansion along with stable prices would drive earnings going forward.

Diversified revenue streamsThe improvement in the commercial viability of sugar byproducts has further sweetened the business prospects for sugar companies. These byproducts are likely to insulate the companies against cyclical lows in sugar prices that occur over a period of every 4-5 years. Integrated sugar companies are expected to derive 15-20% of their revenues from byproducts, which would partially offset the margin pressure given the regulatory support for ethanol and co-generation. In addition, the positive outlook on ethanol globally and emergence of it as an alternative and cleaner fuel would sustain the lure of byproducts.

Exhibit 13: UP to contribute 50% of total capacity (in TCD)

379930

191300

48500 38250

0

100000

200000

300000

400000

All India UP Karnataka Maharashtra

Source: CMIE, ICICIdirect Research

11SUGAR

Playing the devil's advocateWe believe that the fears are overdone and have tried to address the concerns:

Concerns Our View Falling sugar prices World sugar prices have more than doubled during the past 18 months from US 8.0 cents/lb in April

2005 to US 19.7 cents/lb in February 2006. They are currently well off its recent peaks at around 12cents/lb. Extraneous factors such as the high crude oil prices and lucrative ethanol potential areexpected to ensure that the outlook for sugar prices remains stable in the medium to long termperspective, though short term volatility is likely to exist. Much of the domestic and global badnews has already been factored in the market. We expect domestic prices to stabilize slightlylower in the range of Rs 17-18 per kg on a conservative basis. We also do not expect a rally in the sugar prices either from the current levels in the medium term.

Fears of production glut Global sugar demand supply is set for a structural change with ethanol emerging as big opportunity,higher allocation towards ethanol production in Brazil and the exit of the EU from the global sugarmarket would keep prices buoyant going forward.

Margin pressure: Indian sugar companies are likely to witness margin pressure on lower sugar prices and concerns over cane prices moving up ahead of the state elections in Uttar Pradesh.

The earnings of Indian sugar companies are likely to become stable with sugar-byproductscontributing about 15 - 20% of their revenues going forward on the back of integrated & de-riskedbusiness model.

Export Ban: The export ban deprived sugar companies from capitalizing on rising global sugar prices. Continued ban on exports along with higher domestic production is expected to put further downward pressure on sugar prices.

The sugar export ban is expected to be lifted as against 2.074 million tonne of raw sugar imported; only 0.75 mt of refined sugar has been exported. The government is expected to remove the ban on sugar exports sooner or later as sugar companies need to re-export the remaining 1.324 million tonne refined sugar under the export obligation fixed earlier.

Ethanol in a state of flux India's ethanol program is yet to take off in a big way as issues over ethanol pricing and governments lack of commitment towards making ethanol-blended gasoline mandatory is another concern for sugar players, which have lined up impressive ramp up of distillery capacity.

After a long wait, the country plans to implement the National Program for blending 5% ethanol with petrol countrywide from Nov 1, 2006 which would provide fillip to the distillery expansion undertaken by leading sugar companies.

12SUGAR

Compelling ValuationsSugar stocks have witnessed an erosion of 50-60% of their value from peak levels over the past 5-6 months due to easing up of global prices, fears of production glut and other factors such as export ban etc. Sugar stocks are expected to be volatile in the short term due to negative macro news flow, but longer term, we believe there is good value in them.

Fastest growing companies Aggressive capacity expansions and additional revenues from byproducts are expected to improve the top lines of sugar companies by 35-68% over FY05-FY08E, though operating profit margin may come down as sugar prices have eased from higher levels and would stabilize in the Rs 17-18 per kg range. Net profit growth is expected to grow at a CAGR between 26-68% during FY05-08E period. Sugar companies are trading at attractive levels given the impressive return on equity offered even at sugar price realizations of Rs 17.25 per kg, which we believe is very conservative.

Key picksShree Renuka Sugars, Balrampur Chini Mills and Bajaj Hindustan are our best picks among sugar stocks in that order. Historically, these stock have traded above 10x. Currently, Shree Renuka Sugars is trading at 8.5x its FY06 EPS valuation. Balrampur Chini Mills on the other hand has mostly traded above 15x. Since Dec 2004, Bajaj Hindustan has always traded above 10x. The stock was re-rated a year later in Dec 2005 to above 20x. We have taken the lower historical P/E band for all the companies for our upside calculation, which we feel is conservative despite the expected buoyancy in profitability of these companies over the next 2-3 years.

Exhibit 14: All stocks trading at lower historical PE Bands

0

500

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35x

25x

10x

3x

Renuka Sugar

-N

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35x

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15x

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Balrampur Chini

0

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S2

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35x

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Bajaj Hindustan


13SUGAR

Key risks to our viewGovernment regulation: Sugar is an essential commodity and is subject to various regulations such as cane price, export ban, etc. Any intervention by the government to check domestic prices may adversely impact our earning estimates & upside potential.

Supply side disruptions: Any major supply side disruption in key producing countries due to natural calamities such as monsoon, cyclone etc. may affect sugarcane availability and in turn our estimates as well.

Crude oil prices: Sugar prices are now being increasing linked with energy prices. Any adverse downward movement in crude oil prices may prune ethanol's demand potential. Also government's policy initiatives towards ethanol blending would also have a bearing on our estimates.

14SUGAR

q Integrated business model: Renuka Sugars is unique in a way that its business model is different from traditional and other integrated sugar companies. A low capex model, coupled with significant revenues from trading and refining activities, de-risks its business thereby reducing its dependence on availability of cane and established revenue streams such as sugar, power and ethanol.

q High recovery rates: SRSL benefits from the strategic location of its plants in Maharashtra and Karnataka, which have high recovery as compared to its northern counterparts. Additionally, sugar plants in Karnataka and Maharashtra have a operating period of 220 days against 150 days in Uttar Pradesh.

SHREE RENUKA SUGARS (RENSUG)


Shree Renuka Sugars (SRSL), a significant player in the sugar business, is the best play in the mid-cap sugar space.

Integrated and a de-risked business model and one of highest return ratios in the sector make the stock a compelling buy. Trading at P/E of 5.40x EPS of Rs 112.02 for FY08E and at an EV/ EBIDTA of 3.58x, the stock is the cheapest in our universe of sugar stocks. BUY.

Current Price: 613 Target Price: 1120Potential upside 85% Time frame: 12-18mts

Year Sales PAT EPS(Rs) % change y-o-y P/E (x) OPM (%) NPM (%) EV/EBIDTA(x) ROE 2005 795 48 56.10 32.76 20.31 10.65% 7.10% 19.44 36.74%

2006E 1066.85 170.08 71.16 117.23% 8.50 23.65% 17.33% 6.12 50.26% 2007E 2305.56 234.73 98.21 38.01% 6.16 16.18% 11.07% 4.73 41.34% 2008E 2579.77 267.73 112.02 14.06% 5.40 16.46% 11.28% 3.58 32.25%

Exhibit 15: Capacity Expansion

Key Financials

Sugar produced(in TCD)

Ethanol Produced (in KLPD) Power genrated (in MW)

0

5000

10000

15000

20000

25000

30000

FY05 FY06E FY07E FY08E 0

100

200

300

400

500

Pow re

illr

Diste

y

Source: Company, ICICIdirect Research

15SUGAR

BackgroundIncorporated in 1995, Shree Renuka Sugars Ltd (SRSL) is one of the few integrated sugar companies in the country. It has a sugar crushing capacity of 7,500 tcd, which is set to grow to 25,250 tcd by 2008. The company also operates one of the largest raw sugar refineries in the country with a capacity of 1,000 tonnes per day, a 60-kilo litre per day (klpd) distillery and a 20.5 MW co-generation power plant. It also derives additional revenue through its Dubai-based subsidiary, Renuka Commodities DMCC.

Aggressive expansion plans: SRSL is expanding its capacity three-fold (capex of Rs 539 crore) to capitalise on the cyclical upturn in the sector and higher sugar prices. Its proposed 2,000 tpd port-based refinery at Haldia (West Bengal) is a strategic move aimed at addressing the gap in global white sugar trade caused by exit of EU from the global sugar market. Structurally, it will also cater to sugar-deficient countries such as Bangladesh and Indonesia on the eastern belt. The company is also increasing its ethanol capacity from 60 klpd to 450 klpd and co-generation capacity to 103.5 MW, of which 43.5 MW will be used for internal consumption, and any surplus will be sold in the market.

86.95 96.72 101.65 112.02 122.39 126.14 137.08 148.07

0

50

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11% & 16

11.5%& 16

12% & 16

11% & 17

11.5%& 17

12% & 17

11% & 18

11.5%& 18

12% & 18

Recovery Rate & Sugar Prices(per kg)

EP

S

De-risked business model: The company has a low capex model comprising of leased and owned plants that generate higher returns due to their strategic location in high cane-recovery regions of Karnataka and Maharashtra (around 11.5% against 10% in Uttar Pradesh). Additionally, plants in these regions operate for 220 days compared to around 150 days in Uttar Pradesh.

Leveraging: SRSL has a successful track record of taking over sick sugar mills and turning them around. It has also taken mills on lease, reducing its capital expenditure drastically. Most of its expansion projects are financed through debt, helping it to leverage its capex plans.

Exhibit 16: EPS sensitivity


16SUGAR

We expect SRSL's bottom line to register a CAGR of 68% during FY05-FY08E on the back of higher recovery rates, longer crushing season and substantial contribution from its refining and trading businesses. Top line is expected to grow at a CAGR of 54.85% due to volume growth on the back of three-fold jump in capacity.

SRSL is set to report higher-than industry growth and is the cheapest stock in our universe of sugar companies. The stock has retraced over 55% from its peak and currently trades at a P/E of 5.40x its FY08E EPS of Rs 112 and at an EV/ EBIDTA of 3.58x. Traditionally, it has attracted a higher market value due to its integrated, de-risked business model. With the highest return ratios in the sector, we value the stock at 10x its FY08E with a target price of Rs 1120, giving us an upside of 85% from current levels. We rate the scrip an Outperformer.

VALUATIONS


Revenue

0

500

1000

1500

2000

2500

3000

FY05 FY06E FY07E FY08E

Reve

nue

( Rs

cro

re)

Sugar Crushing Sugar Refining Ethonol/Co-generation Trading

357.38

843.74

1073.051073.05

571.37

303.76

357.38

371.33279.18

357.38 62.3078.85247.87160.96

357.38

Profit & Margin

267.73234.73170.08

56.1

10.65%

23.65%

16.18%16.46%

6.78%

17.33%

11.07%11.28%

0

50

100

150

200

250

300

FY05 FY06E FY07E FY08E 0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Net profit Operating Profit Margin(%) Net Profit Margin(%)

Exhibit 17: Revenue & Profitability

305.60

(Rr)

s.c

17SUGAR

COMPANY FINANCIALS (Consolidated)Profit and loss statement (Rs crores)

Cash Flow Statement (Rs crores)Ratio Analysis

Balance Sheet (Rs crores)FY07E FY08EFY06E

FY06 FY07E FY08E

Sales 1066.85 2305.56 2579.77 %Growth 28.70% 116.11% 11.89% Other Income 30.00 30.00 30.00 Raw Material Cost 647.07 1535.50 1724.43 Employee Cost 19.06 44.34 58.82 Other Cost 83.27 198.03 199.49 Depreciation 18.85 33.80 37.20 EBIT 227.63 331.96 381.44 Interest 16.48 26.48 26.48 PBT 226.77 312.98 356.97 %Growth 252.24% 38.01% 14.06% Tax 56.69 78.24 89.24 Net Profit 170.08 234.73 267.73 % Change YoY 203.18% 38.01% 14.06% Equity Shares 2.39 2.39 2.39

Opening Cash 62.76 230.58 153.98 Profit after Tax 170.08 234.73 267.73 Cash Profit 179.57 263.15 299.54 Cash flow after change in working capital 104.77 237.09 283.14 Cash flow from investing activity -166.67 -438.69 -60.27 Cash flow from financing activity 229.72 125.00 0.00 Net cash inflow 167.82 -76.60 222.86 Closing Cash 230.58 153.98 376.84

FY06E FY07E FY08E EPS (Rs.) 71.16 98.21 112.02 Book Value (Rs.) 141.61 237.57 347.33 Operating Margin(%) 23.65% 16.18% 16.46% Net Profit Margin(%) 17.33% 11.07% 11.28% RoNW(%) 50.25% 41.34% 32.25% RoCE(%) 44.68% 37.77% 33.02% Debt Equity 0.61 0.58 0.40 Enterprise Value (Rs. cr) 1421.35 1622.95 1400.09 EV/EBIDTA 6.12 4.73 3.58 Sales to Equity 41.07 88.75 99.31

FY06E FY07E FY08E Equity share Capital 23.90 23.90 23.90 Reserves & Surplus 314.54 543.89 806.23 Secured Loans 190.76 315.76 315.76 Unsecured Loans 15.22 15.22 15.22 Total liabi lities 544.42 898.77 1161.11 Net Block 260.47 565.36 608.43 Capital Work in Progress 0.00 100.00 80.00 Investment 1.00 1.00 1.00 Net Current Assets 282.95 232.41 471.68 Total assets 544.42 898.77 1161.11

Year End (September)

18SUGAR

q BCML will enjoy better integration of operations post-expansion as it will earn higher proportion of revenues from byproducts such as ethanol and power (revenues are tax-free), which in turn would mitigate the downward risk associated with sugar prices and lower realizations.

q The company enjoys improved operational efficiency as all of its sugar units are located within a radius of 200 km, resulting in better inter plant synergies and higher command area. This helps the company in procuring cane at lowest rates as it remains fairly insulated from cane

BALRAMPUR CHINI MILLS (BALCHI)

BCML is a safe play among frontline sugar stocks from a risk-reward perspective available at attractive valuations. Synergies from a integrated business model along with rich product mix makes the stock a compelling buy. Trading at P/E of 8.44x its FY08E EPS of Rs 11.86 and at an EV/ EBIDTA of 6.25x, the stock is among the best bets in sugar sector.


Balrampur Chini Mills Ltd (BCML) is set to emerge as the second largest player in the country after it completes expansion cane crushing capacity to 73,500 tcd in FY08E.


Key FinancialsYear Sales(Rs. Cr.) PAT(Rs Cr.) EPS(Rs.) % change y-o-y P/E (x) OPM(%) NPM(%) EV/EBIDTA(x) ROE(%)2005 930.26 147.39 6.35 15.73 29.81% 18.12% 11.09 31.00%2006E (18 months) 1713.87 220.52 8.89 39.95% 11.25 24.59% 13.99% 7.21 22.11%2007E 1780.65 194.55 7.84 -11.80% 12.76 22.82% 11.88% 7.97 17.03%2008E 2359.06 294.24 11.86 51.25% 8.44 23.65% 13.56% 6.25 21.21%

0

10000

20000

30000

40000

50000

60000

70000

80000

FY05 FY06E FY07E FY08E0

50

100

150

200

250

300

350

Sugar Crushing (in TCD) Distillery (in KLPD) Power (in MW)

Di til ers l y

wPo er



19SUGAR

BackgroundBalrampur Chini is the second largest sugar manufacturing company in India. Currently, all its plants are located in eastern Uttar Pradesh. The company operates six sugar factories with an aggregate capacity of 47,500 tcd, which it plans to expand to 73,500 tcd by FY08E along with distillery and power capacity to 320 klpd and 116.2 MW (saleable) respectively. The company enjoys better operational efficiency as its cane recovery rate is around 10.15%, compared to an average of 9.7% in eastern UP.

q Big expansion plans: BCML is undertaking a combined capex of Rs 1,200 crore to set-up fully integrated green field plants, automation of existing plants and enhancing byproduct capacities at existing locations. The integration along with the expansion would ensure that the company capitalizes on the upturn in sugar cycle and weathers downturn better than peers.

q Focus on inorganic growth: The company is also adopting the inorganic route to grow and has acquired Dhampur Sugar's Rauzangaon unit. It has also picked up a 27.54 % stake in New Delhi-based Indo Gulf Industries Ltd. These acquisitions are synergistic as they are in the vicinity of its existing plants.

q Byproduct revenues: Byproducts should account for 18% of its revenues in FY08E. The company is likely to generate revenues to the tune of Rs 217 crore from co-generation, which will be exempted from taxes and would also be eligible for carbon credits. The thrust on ethanol blending would help it to garner an equivalent amount of revenues from ethanol vis-à-vis power.

Exhibit 19: EPS Sensitivity

7.58

10.268.15

11

13.85

11.4

0

5

10

15

20

9.7%& 16

10.2%& 16

10.7%& 16

9.7%& 17

10.2%& 17

10.7%& 17

9.7%& 18

EPS

14.42

17.43

10.2%& 18

10.7%& 18


20SUGAR

FINANCIALSBCML earnings during FY05- FY08E are expected to grow at a CAGR of 25.87% to Rs 294.25 crore on the back of 38.70% CAGR growth in top line to Rs 2359.06 crore. Operating profit is likely to grow by 28.37% as margins may remain under pressure at 23.65% in FY08E due to recent dip in sugar prices and conservative price realization of 17.25 per kg taken by us. Distillery and co-generation operations are likely to contribute Rs 201.60 crore and Rs 217.60 crore to the top line in FY08E, thereby contributing 18% to its topline for the same period.

BCML is a safe play among frontline sugar stocks from a risk-reward perspective available at attractive valuations. Synergies from a Integrated business model along with rich product mix makes the stock a compelling buy. Trading at P/E of 8.44x its FY08E EPS of Rs 11.86 and at an EV/ EBIDTA of 5.91x, the stock is among the best bets in sugar sector. The stock offers an upside of 42% to Rs 142 levels even a lower historical P/E average of 12x.

Source:ICICIdirect Research

Revenue

692.32

1428.89 1480.621939.85

191.21

151.20 138.60

201.60

48.10

133.78 161.43

217.61

0.00

500.00

1000.00

1500.00

2000.00

2500.00

FY05 FY06E(18) FY07E FY08ESugar Production Ethanol Produced Co-generation

Profit & Margins

294.24194.55220.52147.39

29.83%

24.59%22.82% 23.65%

18.14%

13.99%11.88% 13.56%

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

FY05 FY06E(18) FY07E FY08E0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%



r)(R

s.c

)(R

s.r c

21SUGAR

COMPANY FINANCIALSProfit and loss statement (Rs crores) Balance Sheet (Rs crores)

FY06E(18 M) FY07E FY08E Sales 1713.87 1780.65 2359.06 %Growth 84.24% 3.90% 32.48% Other Income 2.95 2.95 2.95 Raw Material Cost 996.28 1059.01 1387.47 Employee Cost 51.53 54.78 71.77 Other Cost 144.42 153.52 201.13 Depreciation 66.92 78.87 96.64 Interest 38.86 57.76 57.76 EBIT 320.86 295.01 416.60 %Growth 8.76% -29.18% 123.69% Tax 61.48 42.71 64.59 Net Profit 220.52 194.55 294.24 % Change YoY 13.35% -33.88% 99.72% Equity Shares 2.48 2.48 2.48

FY06E(18 M) FY07E FY08E Equity share Capital 24.82 24.82 24.82 Reserves & Surplus 972.75 1117.66 1362.26 Secured Loans 555.15 825.15 825.15Total liabilities 1552.72 1967.63 2212.23 Net Block 902.54 1329.13 1757.49Investment 0.00 0.00 0.00Net Current Assets 650.34 638.66 454.91Total assets 1552.88 1967.79 2212.40

Cash Flow Statement (Rs crores) FY06E(18 M) FY07E FY08E Opening Cash 16.33 241.46 325.90 Profit before Tax 282.00 237.25 358.83 Cash flow after change in working capital 142.31 369.54 348.76 Cash flow from investing activity -371.01 -505.46 -525.00 Cash flow from financing activity 453.83 220.36 -49.64 Net cash inflow 225.13 84.44 -225.88 Closing Cash 241.46 325.90 100.02

Ratio Analysis



22SUGAR

q Bajaj Hindustan is a leveraged play on volumes with the company expanding distillery capacity five-fold to 800 klpd by FY08E and would be a major beneficiary of pickup in ethanol blending and its re-pricing upwards

q The stability of revenues from byproducts mitigates the downside risk to a certain extent and favorable improvement in sugar realization would improve revenue and profit visibility.

BAJAJ HINDUSTAN (BAJHIN)

The company is a trendsetter in the industry and is expected to continue to command a slight premium over its peers due to its aggressive business style, economies of scale and strong cash flows. Despite lower RoEs and margins, volumes would drive top line and bottom line at a CAGR of 68.81% and 39.03% respectively over FY05-08E, thereby making the stock attractive at 11.66x FY08E EPS of Rs 26.33.


Bajaj Hindustan, the largest sugar company in India, is set to catapult to the top 5 sugar companies globally, led by more than doubling of its crushing capacity to 1,35,000 tcd during FY05-08E.


Key FinancialsYear Sales(Rs. Cr.) PAT(Rs Cr.) EPS(Rs.) % change y-o-y P/E (x) OPM(%) NPM(%) EV / EBIDTA(x) ROE(%)2005 881.38 140.27 14.60 21.92 26.15% 16.76% 16.36 27.50%2006E 1786.56 214.30 14.76 1.06% 21.35 18.12% 12.65% 15.83 13.92%2007E 3033.71 277.72 19.27 30.60% 16.35 18.52% 9.66% 10.00 15.34%2008E 4242.74 376.95 26.33 36.65% 11.96 17.48% 9.37% 7.62 17.29%


0

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FY05 FY06E FY07E FY08E0

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Sugar Crushing (in TCD) Distillery (in KLPD) Power (in MW)

Power

lry

Disti l

e


23SUGAR

BACKGROUNDBajaj Hindusthan Ltd (BHL), incorporated in November 1931, is the country's largest sugar manufacturer and operates seven plants in western Uttar Pradesh. It is set to widen its competitive edge further by adding an incremental capacity of 1,04,000 tcd along with five fold jump in distillery capacity and foray into medium density fibre board (MDF) and particle board (PB). The company also stands to gain from Uttar Pradesh state government's incentive policy, which would entail inflows to the tune of Rs 300 crore in the form of capital subsidy.

q Leveraged play: BHL enjoys better economies of scale as well as sugarcane pricing power when compared to smaller mills. The company stands to gain in terms of better sugar cane availability this year due to its record of timely payments to farmers and improvements in recovery rates. Recovery rates had dipped to below 10% in western UP in the previous year. Additionally an improvement in sugar prices would further provide boost to its margins though we have not factored in the same for our estimates.

q Diversifying into MDF and PB: BHL has initiated a bold step of entering into manufacturing of medium density fibre board (MDF) and particle board (PB), which will use the excess bagasse generated as the raw material. MDF and PB are likely to generate incremental revenues to the tune of Rs 300 crore annually beginning FY08E with an EBIDTA margin in the range of 30-40%.

q Acquisition to trigger further upsides: In addition to organic route for meeting growth objectives, the company is aggressively following the inorganic route as well. It acquired Pratappur Sugar's unit with capacity of 3,200 tcd and plans to scale it up to 40,000 tcd by next year. It now plans to foray into Brazilian market with a cash chest of $500 million. Gaining a foothold in the Brazilian market would enable the company de-risk its business model further as the production cost of ethanol in Brazil is half of the global average. Also, Brazil has the highest recovery rates of 14-15%.

Exhibit 22: EPS Sensitivity


15.67

24.217.27

26.33

35.39

27.4

36.99

46.59

0

10

20

30

40

50

9.5%& 16

10% & 16

10.5%& 16

9.5%& 17

10% & 17

10.5%& 17

9.5%& 18

10% & 18

10.5%& 18

Recovery Rate & Sugar prices(per kg)

EP

S

24SUGAR

FINANCIALSThe company is expected to notch up significant top line and bottom line growth over the next 2-3 years on the back of impressive volume growth driven by aggressive expansion and higher contribution from byproducts. Revenues are slated to jump 2.37 times to Rs 4242.74 crore by FY08E from FY06, while net profit is likely to spurt 1.76 times to Rs 376.95 crore during the same period. BHL is expected to reap the maximum benefits in the event of sugar prices firming up to their previous peak levels.

The stock is expected to continue to command a slight premium over its peers. Despite lower RoEs and margins, volumes would drive its top line and bottom line by a CAGR of 68.81% and 39.03% respectively over FY05-08E period thereby making the stock attractive at 11.66x FY08E EPS of Rs 26.33. We believe investors can look for significant upsides to the tune of 29% from current levels to Rs 395 at 15x FY 08E EPS.


Profit & Margins

140.27 214.30 277.72 376.95

26.15%

18.12% 18.52%17.48%

16.76%

12.65%9.66%

9.37%

0

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100

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FY05 FY06E FY07E FY08E0.00%

5.00%

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Revenue

0

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1000

1500

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FY05 FY06E FY07E FY08E

Sale

s (R

s Cr

ore)

Sugar Ethanol Power MFB/PB

802.259.2

1663.5

168.0

119.8

2700

382.7

404.8

3645

300.0

119.8

25SUGAR

COMPANY FINANCIALSProfit and loss statement (Rs crores) Balance Sheet (Rs crores)

Cash Flow Statement (Rs crores)Ratio Analysis

FY06E FY07E FY08E Sales 1786.56 3033.71 4242.74 %Growth 102.56% 69.81% 39.85% Other Income 19.76 19.22 18.69 Raw Material Cost 1140.63 1978.85 2851.45 Employee Cost 55.64 72.40 104.32 Other Cost 139.10 241.32 312.96 Depreciation 68.86 110.44 143.97 Interest 0.00 66.10 559.17 EBIT 238.11 422.16 614.95 %Growth 39.77% 77.29% 45.67% Tax 23.81 78.33 106.32 Net Profit 214.30 277.72 376.95 % Change YoY 52.78% 29.59% 35.73% Equity Shares 14.14 14.14 14.14

FY06E FY07E FY08E Equity share Capital 14.14 14.14 14.14 Reserves & Surplus 1525.11 1795.82 2165.75 Total debt 944.33 944.33 1084.33 Total liabilities 2483.58 2754.28 3264.21

Net Block 1010.43 1669.99 2147.01 Capital work in progress 770.00 621.00 0.00 Investment 5.07 5.07 5.07 Net Current Assets 698.08 458.23 1112.13 Total assets 2483.58 2754.28 3264.21



FY06E FY07E FY08EOpening Cash 7.76 510.49 42.42Profit before Tax 238.11 356.06 483.27Cash flow after change in working capital 129.21 159.94 -21.37Cash flow from investing activity -769.58 -621.00 0.00Cash flow from financing activity 1143.10 -7.02 132.98Net cash inflow 502.73 -468.08 111.61Closing Cash 510.49 42.42 154.03

26SUGAR

ICICIdirect Research DeskHarendra Kumar Head - Research and Content [email protected]

Pankaj Pandey [email protected] Mehta [email protected] Kumar [email protected] Chhoda [email protected] Kedia [email protected] Khedkar [email protected] Batra [email protected] Jain [email protected] Sankhe [email protected] Manyal [email protected] Padmanabhan [email protected] Crasto Technical Analyst [email protected] Shah Technical Analyst [email protected] Mallya Editor [email protected] Talekar Production [email protected] Rai Production [email protected]

DISCLAIMER: The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Brokerage Services Limited. "The author of the report hold investment/open position in one of the companies mentioned in this report. ICICI Brokerage Services Limited (IBSL) may be holding a small number of shares/ an open position in the above referred companies as on the date of release of this report." This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgement by any recipient. The recipient should independently evaluate the investment risks. ICICI Brokerage Services Limited and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Actual results may differ materially from those set forth in projections. ICICI Brokerage Services Limited may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject ICICI Brokerage Services Limited and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction.

RATING RATIONALEICICIDirect endeavors to provide objective opinions and recommendations. ICICIdirect has no investment banking relationships and assigns ratings to its stocks according to their notional target price vs current market price and then categorises them as Outperformer, Performer, Hold, and Underperformer. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock.

Outperformer: 20% or more;Performer: Between 10% and 20% Hold: +10% return; Underperformer: -10% or more.

SUGAR

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